France recently joined a growing list of countries around the world which have created listed tax transparent vehicles for real estate investment. Similar vehicles have existed for some time in the US (REIT), Australia (Listed Property Trust), The Netherlands (FBI) and Belgium (SICAFI). The French version, Sociétés d’Investissements Immobiliers Cotées (known affectionately as F-REITs) was created at the end of 2002 and provides exemption from corporation tax and capital gains tax on real estate investment activities. 
The F-REIT grew out of a dialogue between the French government and the property companies which culminated in a trade off under which the Treasury granted new tax privileges in exchange for an exit tax equivalent to 16.5% of the embedded gains within the property portfolio. The tax is payable in four annual instalments and, assuming full adoption, is estimated to generate additional revenues for the French Government of around E1.4bn. Unibail, the largest French property company, estimates that it will pay a total exit tax of E387m which it expects to finance from corporate tax savings over the same period (see table). 
The French government enacted the broad principles of the new regime in the Loi des Finances 2003 and further detail will follow shortly. What we know currently is that an F-REIT must be a company listed on a French stock exchange with a minimum share capital of €15m and that it will be required to distribute 85% of the net income and 50% of the capital gains derived from its real estate investment activities. Unlike its Dutch and Belgian counterparts it will not be subject to restrictions on foreign ownership or gearing levels and real estate development and management activities are permissible. 

Impact on French property 
It is expected that the major French property companies will opt for the new regime as soon as the detailed legislation is published. Companies wishing to opt for the new regime must do so before the end of the fourth month of the year of election (for 2003, the deadline is exceptionally 30 September). The option is an irrevocable one and cannot be reversed, furthermore any company that leaves the regime within 10 years will have to pay an additional exit tax based on the corporation tax rate then prevailing.  
The regime will affect the existing property companies in a number of ways. We focus here on the impact on dividend payouts. Under the new regime, companies will be required to distribute 85% of the net income derived from renting buildings. Net income will be higher than previously as it will be untaxed but this will be offset by an increased depreciation charge resulting from the revaluation of the assets required to calculate the exit tax. F-REITs will also be required to distribute 50% of the gains made from disposals of assets within a two-year period. The overall impact should be a significant increase in the dividend payable. On the other side of the coin, as F-REIT dividends will no longer attract a tax credit (avoir fiscal) a significant increase in the cash payment will be required for French investors. 
Most companies have given some guidance on expected future dividends. Some, like Société Foncière Lyonnaise, have provided comfort that shareholders will continue to receive attractive dividends going forward whereas Unibail went as far as announcing a specific dividend target – well above historic levels. Market commentators anticipate that net dividend yields will be around 5-6%. For international investors the significant increase in net dividends should be very attractive even if withholding taxes will still be applicable. 

The future for French property companies 
In the short term the companies are likely to enjoy the increased freedom which tax free status confers but are unlikely to change their basic approach. The action is likely to be in the stock market with the major shareholders expected to tap the demand for high yield property shares with a flurry of share placings. The early 1990s saw explosive growth of the US REIT and Australian LPT markets as investors used the vehicles to provide liquidity for their real estate investments. 
The F-REIT regime may also prove attractive for international property companies with French portfolios. Vastned and Wereldhave have created captive SICAFI in order to hold their Belgian investments and they might follow a similar path in France. UK groups Hammerson, Slough Estates and CLS, all of whom have substantial French portfolios, may also benefit. It may suit some of the investing institutions to own their property through tax neutral listed companies and corporates could sell property to F-REITs for a combination of cash and shares as part of an exit strategy as they do in Belgium. 
In the longer term the new regime provides investors with a tax transparent liquid alternative to direct property investment and as they become familiar with the benefits of holding property through F-REITs their preferences will help to shape the new issues market. 
The precedents set by other countries, suggest that gearing is likely to be at a maximum of 50% loan to value. Development activity, which will continue to be taxed and increases the volatility of earnings and dividends, is likely to be less popular with investors. 
The other REIT markets have also seen a shift towards specialisation, allowing investors to allocate their investments between the various real estate sectors. In the US, 92% of all REITS are focused on one asset class such as offices, retail or residential. The popularity of these vehicles has also led to the emergence of unusual asset classes, with healthcare and self-storage REITs alongside the more traditional sectors. 

Private investors 
Much of the success of the REIT industry world-wide is based on direct and indirect buying by private investors. Private investors are estimated to represent around 30% of the shareholder base of the REITs, a higher proportion than is the case in countries where property companies pay tax. The Australian Listed Property Trust sector has grown with the investing public’s confidence in the combination of security and yield which it offers – to the extent that the sector now represents 8% of the entire stockmarket and dominates ownership of Australian commercial property. GPT, one of the longest established and largest trusts has generated a 14.3% total return since inception and yields 7.0%. The same trend is in place in Germany where the open-ended funds have attracted record sums, in large part from the retiring middle classes who are releasing equity from their houses by trading down while at the same time looking for yield to boost their pensions. 
In France, the F-REITs will be eligible for the plan d’épargne en actions (PEA), a tax transparent investment wrapper similar to the ISA in the UK. Investors could hold F-REITs through their PEA to generate a tax-free income stream and, if this catches on, this could become a principal source of demand for F-REITs. 
The new F-REIT regime is undoubtedly a welcome boost for the real estate sector in France, but we do not believe it will result in a major revolution in the short term. The future of French property companies will depend to a large extent on what investors are looking for. An increased focus by investors on yield and security should however advance the case of the F-REITs significantly.  
Rob Wilkinson is a director of real estate investment banking at Eurohypo. Adrian Elwood is director of research at Eurohypo